Reasons Behind The New Year Selloff

2016 certainly came in storming. Right off the bat, investors were met with a major selloff.

The U.S. stock market was, at one point, suffering through its worst opening day of a new year since 1932. It ultimately regained its footing, relatively speaking, and January 4, 2016 ended up being the worst start to a new year since 2008.

So what the heck is going on?

Well, it’s a continuation of last year’s woes. December, normally the strongest month of the year, was down – and now, there’s an extra dose of geopolitical concern on top.

Point the Finger at China

When things go wrong, Washington and Wall Street have one trait in common: They love to place the blame on those darn foreigners.

In most cases, China is the convenient whipping boy. The same was true on Monday, as China was blamed for the selloff.

The mainland Chinese stock markets plunged for a number of reasons – not the least of which is that their newly enacted circuit breakers actually accentuated the selling.

The selling itself was triggered by worries over the end of the lockup period, imposed by Beijing after the August swoon. Additionally, IPOs are resuming, draining the market of liquidity.

Despite what CNBC says, though, the selloff was not triggered by worries about the economy.

The Purchasing Managers Index (PMI) on manufacturing activity came in relatively close to expectations. On the other hand, the U.S. Institute of Supply Management (ISM) Manufacturing Index fell to a five-year low, but that hardly got any play on U.S. media outlets.

Chinese investors aren’t stupid. They know that the services sector now accounts for roughly half of the country’s economic activity. And that sector is soaring.

Plus, Chinese investors know that more bumps in the road are coming as China transitions to a more services-focused economy. Thus, there’s no reason to panic sell on one manufacturing number.

The real reason for the China concerns was that the yuan hit a five-year low versus the dollar. In fact, the whole selloff through Thursday centered on the fact that China’s currency fell by 1% versus the dollar. So it’s much ado about 1%.

But shame on any money manager who was caught off guard by that. The Chinese clearly telegraphed that move to the markets last month when it said its currency would now be pegged to a basket of currencies, not just the dollar.

China’s foreshadowing of the move was even clearer than the Fed announcing its intention to raise rates in 2015.

Thanks to that dollar peg, China’s currency soared 35% versus its trading partners over the past six years. That cut into its competitiveness and hurt its economy. We should expect further weakening versus the dollar as long as the dollar remains strong.

Geopolitics

Now, the second reason behind the selloff was more genuine.

Geopolitical turmoil in the Middle East has continued ratcheting up. The 1,400 year-old tensions between Sunnis and Shias continues with the Saudis (Sunnis) and Iranians (Shias) front and center.

There won’t be a direct confrontation between the two, but their proxy wars in Yemen, Syria, Iraq, Lebanon, and Bahrain will continue to rage on.

Oil’s reaction to this heightened tension should send any remaining bulls to the hills. Oil actually finished the day down.

If rising Saudi-Iran tension doesn’t ignite a bid, it may be a longer bear market than most think. I’m sure most players in oil realize the Saudi-Iran “war” for oil market share is just beginning.

Meanwhile, North Korea decided to stir the pot even further by allegedly testing a hydrogen bomb on January 6. Now, the United Nations is deciding how to punish North Korea for its actions.

Problems at Home, Too

Finally, the third reason for the stock swoon is domestic.

The debacle that is the junk bond market continues, led by energy. Both mergers and acquisitions and stock buybacks are at record highs, thanks to the Fed’s easy money policies. The last time both were at record highs was in 2007.

The valuations of tech unicorns are falling. Mutual fund companies like Fidelity have been forced to mark down the value of their holdings. Let’s hope they don’t become unicorpses.

The Greenspan put is still in place. If the stock market gets weak in the knees, the Fed will come to the rescue. Interest rate hikes will end and, if needed, the Fed will come with QE4 and even negative interest rates.

The current Nifty Nine will simply rotate to other stocks. Perhaps Apple Inc. (AAPL) will become the A in a new FANG?